A Round Trip Through a Crowdfunded Equity Investment

[Update Prior to Publication: I first wrote this post a couple of months ago. It was written now that after several years of investing with, monitoring, and writing about RealtyShares, I was finally comfortable giving them a pretty strong recommendation. I had been round trip with four debt investments and an equity investment and the last of my six was paying as expected. They had one of the highest volumes for investments and even those who monitor the industry closely weren't aware they were rapidly running out of operating capital. It seemed like a decent advertising partnership for The White Coat Investor and I could easily write about my own experience there. Then a few weeks ago, after I'd written this post but before it ran, a bomb dropped. It turned out RealtyShares spent way too much money trying to grow too fast. They'd blown through $63 Million and had run out of investors' money in the company itself. Like Icarus, it seems they had flown too close to the sun.

Now, we always knew that of the 120+ real estate crowdfunding websites out there that there were going to be a few casualties. In fact, I expected 90% of them to fail or consolidate over the next decade or so as this brand new industry matured. But I'll be honest, I thought RealtyShares would be one of the survivors. I wasn't the only one surprised; the CEO of one of its competitors said: “It’s surprising to see the news on RealtyShares given how strong the market currently is and has been over the past several years.”

Now, the company isn't actually going out of business…yet. They are, however, no longer seeking out new real estate deals nor new real estate investors. They do plan to continue servicing the existing investments/investors, so presumably, they'll still be around in some form or another half-decade or so. It wouldn't surprise me to see them be bought up or even make a comeback. They say, and I believe, that those with current investments there are going to be just fine. They made their usual payment on my last investment there just like clockwork this month (as all the other payments have been.) But if you're interested in pursuing real estate investing through a crowdfunding platform going forward, you're going to need to look elsewhere. Now, onto the post as originally written, with some recommendations at the end.]

Regular readers know that for the last few years I've had a bit more real estate in my portfolio than in previous years. This has taken the form of funds, individual syndications bought directly from the syndicator, and syndications bought through several of the crowdfunding companies such as RealtyShares.

Since these crowdfunded companies are relatively new, and the lifecycle of an equity syndicated investment can be long, it can be hard to answer the most common question I get about these from readers- “Should I invest in them?” I've kept readers up to date once or twice a year on how my investments are doing, but I recently had an event that I thought was worthy of a blog post. For the first time, I have had an equity investment go “full-cycle” or “round-trip.” I thought it would be instructive for readers to walk through it from beginning to end all at once and describe what happened.

How Crowdfunding Works

Before we get into the weeds, let's make sure we're all on the same page. A “syndicated” investment means it is bought by a bunch of different investors. The syndicator puts the deal together, gathers the investors, collects the money from investors,  manages the investment, pays the distributions to investors, sells the investment, and distributes the principle to the investors, all in return for a handsome fee.

With a crowdfunding site, there is another layer of fees that go to the crowdfunding company/site. In exchange for paying that, the investors often get a lower minimum than they would get going directly to a syndicator and they get the benefit of the crowdfunding company's due diligence. While they are incentivized to gather as many assets/deals as they can, they are also incentivized to have an excellent track record of good investments.

The investment is generally placed into its own Limited Liability Company (LLC) so the investors are only on the hook for their entire investment, despite the frequent use of leverage in the investment. Some investments are “equity” investments, where the investors literally own the property and receive the profits it earns. Other investments, usually for shorter terms, are “debt” investments, where you loan money to a developer, usually a house flipper.

RealtyShares Retail at Canyon Center

About three years ago I saw an investment opportunity from RealtyShares land in my inbox. This happens most weekdays if you've signed up with multiple crowdfunding companies, so it isn't a particularly rare event. What was rare, however, was the property for sale was literally a mile away, a retail/strip mall we shop at all the time. It is the closest grocery store to our house. I thought it would be cool to be able to say I owned it every time I drove by, the financials looked reasonable to me, and I could afford the minimum investment. Plus, there would be no additional state income tax to pay!

The Original Listing

Here's what the original listing looked like:

So now that we know all about the property, let's learn about the deal.

So I will be a member of the RealtyShares LLC, which will invest in the Pacific Castle Canyon Center LLC. I get the first 6% that it makes, then 70% of whatever it makes above and beyond that. The whole thing should be over in less than 5 years. Here's what the finances looked like:

Basically, the property cost $8.5M. It was being purchased with 44% equity, 1/3 of which was coming from the sponsor itself. The other 54% of the purchase price was borrowed. Between 1/3 of the equity being the sponsor's money, and 30% of cash flow above and beyond the 6% preferred return going to the sponsor, they were incentivized pretty heavily to make sure this thing did well.

What Actually Happened

There were dozens (? hundreds) of more pages of what was supposed to happen with the investment, but those were the highlights. Now, let's talk about what actually happened.

On December 7th, 2015, RealtyShares cashed my $5,000 check. From that point on, this investment was basically just mailbox money to me. They sent updates from time to time, but mostly I just saw the distributions in my account. There weren't very many highlights, which is good since I like my investments boring. Let's go through them.

The first distribution wasn't until February 24, 2016. It was a double distribution, so I got $50. $25*12 = $300, or 6% of my $5K investment. Each month after that, for nearly 2 years, I had $25 deposited into my checking account. Not quite like clockwork, but no missed payments.

Toward the end of 2017, they sold off a “pad” on the property, you know one of the little spaces in the corner of the parking lot where they build a Burger King. This outlying building was subsequently razed and rebuilt as a bank, but I no longer own it. My share of that was $1,081.08. Then my monthly payments dropped from $25 to $19.59.

Then, in September 2018, the property was sold. On October 29th, I got my capital back and the profit from the sale. The overall projected return was 18.2%. RealtyShares claims I made 18.3%. Using XIRR, I calculate 17.77%. That's actually pretty typical for an equity investment. I don't know how these guys calculate their returns, but they always seem a little higher than when I calculate them. I think it's because my money sat there for a month before the property and for a month after they sold it. Here's what my cash flows looked like:

That's a 0% return in 2015, a 6.17% return in 2016, a 5.12% return in 2017, and a 39.72% return in 2018, for an overall annualized return of 17.77%. Basically, I got all my money back plus $2,669.11. Not too shabby.

Let's compare it to another one of my investments, just for fun. Let's use the Vanguard REIT Index Fund.

According to Vanguard, this fund had the following returns:

• 2016: 8.50%
• 2017: 4.94%
• Through October 30, 2018: -1.24%

Although the cash flows obviously don't match up, my actual returns in the two investments were as follows:

Obviously, I feel like I was compensated for the risk and illiquidity I took on. How much additional risk and illiquidity are you willing to take on to have 14% higher returns? Quite a bit probably.

Should You Do This?

Yes, you should have bought Retail at Canyon Center when I did; you would have made 17.77%. Oh, that's not what you meant? You mean should you invest in crowdfunded real estate and with RealtyShares specifically?

Well, I guess that depends. But certainly, investments like this can make up a portion of a reasonable portfolio.

Here's where I think this type of investment shines:

Imagine a doc who wants to add real estate to the portfolio but wants higher returns than the Vanguard REIT index fund is offering and wouldn't mind having less correlation with the stock portion of her portfolio. She wants to have a little more control into exactly what she is invested in but definitely doesn't want any calls to repair toilets. She qualifies as an accredited investor based on income, but really doesn't have that large of a portfolio and won't be investing that much each year. For example, let's say the portfolio is $500K and she wants to put 10% of her current nest egg and 10% of the $50K she plans to invest each year going forward. This $50K + $5K a year doesn't work for a private real estate fund or going directly to a syndicator. Maybe, just maybe she can get into a single syndicated deal once every 5-10 years with that type of money. But what can she do? She can buy 5-10 of these crowdfunded real estate deals now, add a new one each year, and replace them as they mature.

Are there risks? Sure. To start with there is severely limited liquidity. Then there are all the usual real estate market risks, syndicator risk, and crowdfunding site risk. You're not going to make 18% without taking some risks. Are you going to pay a lot more in fees than you'll be paying Vanguard? Without a doubt.

What about RealtyShares? 

I have had 6 investments with RealtyShares, 5 debt and 1 equity. They've all paid as agreed and I got all of the principal back. No guarantee that will be the same experience you have of course, but certainly my record shouldn't disqualify RealtyShares from your consideration. [Of course, the fact that they are no longer taking new investments will!-ed]

They're one of the big players in this market and have been around since 2013. They've done 543 round trips and have another 340 currently. I'm sure they didn't all do as well as this one and that if there is a downturn, that many of those currently underway may not turn out as projected.

They had been partnering with us here at The White Coat Investor for years and made used to be on my short list of recommended crowdfunding companies. Apparently, they were paying us too in affiliate fees or something, but I'll be honest, not much of that $63M they burned through ever came to me.

What Now?

If you're still interested in buying syndicated real estate investments like this one through crowdfunded companies, I do have some other recommended companies, including these:

• CrowdStreet
• RealCrowd
• RealtyMogul
• Equity Multiple
• FundRise
• Roofstock
• PeerStreet
• CityVest (more info on Monday)

Whether you should pay any attention to my recommendations or not given the fact that RealtyShares was on that list until the day they quit taking new investments is an entirely different question. Obviously, this is a good example of why diversification matters. Diversification protects you from what you don't know and I was always careful to spread my bets among the companies in the industry. Certainly, it is not unreasonable to skip the entire industry and perhaps even the entire asset class. There are no called strikes in investing. But here are some alternatives:

1. Invest through another crowdfunding company.
2. Go directly to the syndicators.
3. Use a private real estate fund.
4. Buy your own real estate properties or hard money loans directly.
5. Use the Vanguard REIT index fund.
6. Skip real estate altogether.

What do you think? Were you in on this investment? Were you happy with it? Have you invested in real estate through RealtyShares? How was your experience? Does this new development sound the death knell for crowdfunding companies? Why or why not? Comment below!